Question

In this section of our study we looked into the principal agent problem, which stems from separation of ownership from management in corporations. This could be more evident in larger corporations. Can you discuss and bring reasons for and against this argument? Furthermore, can you briefly share a few ideas which may be helpful for solving this problem in where they may rise?

This is all I was provided.

Answer 1

For a firm to work , the roles of management and stakeholders are usually segregated . The role of the management is to bring in profits from the decisions of the firms while the role of stakeholders is provide the financial backing to the the plans which need to be executed to gain maximum profits. Hence for the above circumstances agents are the managers while principal are the owners.

The problems between the two arises when the interests of one party doesn't matches the other. The grounds of differences is majorly the risk taking atitude. The managers want more profit and have nothing at stake. If they extract more profits , their salaries rises and even can get promoted. Hence the odds of risk taking are very beneficial. On the other hand, if we are talking about the owners or stakeholders, they would avoid taking high risks, as stakes of losses are high for them , they will loose their wealth.

For a large firm , this division gets even larger as the stakes of risk are higher. The investments are higher , the risks are higher and the faulter can be higher. This makes the stakeholders take a defensive attitude while the managers want to exploit the position of being a large firm in the market.

The situation can be solved if the roles of manager and stakeholders are not segregated very definitively. Meaning the stakeholders can work for the management and give an insight to both sides. Other method can be the decision of stakeholders that losses and profits will be born equally by management also, which rises the interests of management to do better. Further offering shares of the firm to management also generates more responsibility on the part of management and decisions are made to maximize profits , with minimal risks.